Hard Lessons in Modern Lending – Cont’d – post #3

When banks move to stem problem loans, they follow a standard procedure, says Mitchell D. Weiss, a consultant who ran financing subsidiaries at Webster Bank and SunTrust. Underwriters are always looking for patterns in the numbers. Once they identify a problem group (“You might notice that real estate developers in Florida are having a higher instance of write-offs,” Weiss says, by way of example), they put those companies on a watch list. Then, the bank starts looking for red flags: a late payment, a missed financial covenant, or a sudden drop in business.

During normal times, banks can be flexible. After a crisis, however, the stakes are much higher. When banks are under pressure from shareholders and regulators, there is little room for subjective judgments, exceptions, or forgiveness. If a “watched” company’s credit agreement is subject to annual renewal, Weiss says, it may not be renewed. “It’s not personal,” says Weiss. “In these meetings–and I’ve been in these meetings–lenders will say, ‘These are really nice people. It’s really too bad what’s happening to them. Move them out of the bank.’ ” During the recession, contractors, lumberyards, printers, and other companies tied to struggling industries came up again and again in these analyses.

When a bank decides to sever ties, a ticking clock starts for the business owner. He or she must find a new bank to refinance the loan or pick up the balance of the credit line, typically within 90 days, at which point the full balance “balloons” and becomes due immediately. Money that might have gone to purchase inventory, pay staff, or keep the lights on must go to cover the principal, or the company will default and go out of business.

When a large bank decides to retreat from an entire industry, it can have seismic effects. On October 24, 2008, the day PNC announced it would acquire National City, becoming the fifth-largest bank in the U.S., CEO James Rohr identified a $20 billion distressed-assets portfolio of bad residential real estate development loans, subprime residential mortgages, and brokered home equity loans. He also went a step further, saying the bank would begin “accelerating efforts to exit their noncore loans.” Bank spokeswoman Amy Vargo specifically cited “equine lending” (loans to horse farms), payday lenders, and some mortgage lenders. PNC wound up shrinking its commercial loan portfolio of the newly combined banks by $21 billion, or 21 percent, over the next two years. Loans to manufacturers alone decreased by $3.9 billion–the equivalent of 30 percent of its manufacturing portfolio in 2008.

The moves reverberated among customers, many of them legacy National City clients in its Rust Belt footprint across Michigan, Ohio, and Illinois. In Mentor, Ohio, Brendan Anderson, chief financial officer and co-owner of Stam, got a call from his new PNC loan officer on June 8, 2009. Revenue at Stam, which makes air-intake and exhaust lines for heavy machinery, had fallen steeply. But Anderson had kept up the company’s loan payments. Still, the rep told him that PNC now took issue with the way Stam calculated its net worth. As the bank saw it, the company’s value had fallen below a mandated level, which put Stam in violation of its loan agreement. Anderson quickly dug up an e-mail from his old National City loan officer spelling out how the two sides agreed to calculate net worth. The dispute continued for weeks. Finally, the PNC rep was blunt: “You’ve been designated an exit credit. My goal is to get you out of the bank.” (PNC declined to comment on specific clients.)

After the PNC breakup, Stam managed to move its equipment loan and revolving line of credit over to Park View Federal Savings, but CEO Kent Marvin says he’s no longer interested in expanding. He will keep the 50 employees he has and cap hiring there. “It’s just not worth it,” he says. Demand is increasing, but the investment required to add another shift wouldn’t pay off for at least two to three years, estimates Anderson, the CFO. That’s too long, he says, and cash is too tight. “Heaven forbid there’s another recession.”

Business owners who decide to fight their banks hit a different set of challenges. David Moyal runs one of the last privately held printing operations in New York City, churning out programs and fliers for Broadway shows and the fine print for prescription drugs like Lipitor. Over the years, as demand for paper products declined and larger competitors hammered down prices, Moyal managed to stay competitive by using the latest, fastest presses.

In 2005, he expanded to New Jersey, opening a larger facility just on the other side of the Holland Tunnel, using equipment loans from People’s Capital and Leasing Corporation, a subsidiary of People’s United Bank. On July 24, 2008, Moyal purchased a custom-made, state-of-the-art, $3.8 million Mitsubishi sheet-fed printing press, capable of printing 10,000 two-sided pages an hour. As it had in 2005, People’s provided him with a down payment for the new press (in this case, $200,000) and made a written offer to finance the rest. But in January 2009, after the press had been assembled and shipped and was ready for delivery, People’s refused to make the loan.

The bank, Moyal learned, was in the midst of a rapid retrenchment. Rather than increasing equipment financing 20 percent in 2009, as it had expected before the crisis, People’s CEO Philip Sherringham had told analysts that the bank planned to “put the brakes” on the portfolio. Loans to printers would fall 32 percent.

Moyal called the bank “9, 10, 15 times” to see what could be worked out. Meanwhile, as he was stuck with his old presses and unable to match competitors’ prices, sales cratered. When he called People’s to see if he could extend his payment schedule, his loan officer told him that the bank had decided not to change loan terms for printers unless they were already defaulting.

In September 2011, People’s United sued Moyal to get back the $200,000. Moyal, incensed, is now countersuing the bank for breach of contract and fraud. (People’s United did not return numerous phone calls for this story.)

Suits like Moyal’s face steep odds, says John McFarland, a partner at Houston-based Joyce, McFarland & McFarland who represents banks in lending-litigation cases. Loan contracts often provide outs for lenders, including “material adverse change” clauses that can cover a sudden drop in sales. Even the most bitter breakups between borrowers and lenders rarely end up in court. “There’s a lot of gnashing of teeth and some really badly damaged long-term relationships,” says Buzz Trafford, a managing partner at Porter Wright in Columbus, Ohio, who has represented both sides on debt issues. “But there’s not a lot of litigation.”

So what should entrepreneurs do? Weiss, who now is a finance professor at the University of Hartford in Connecticut, advises entrepreneurs to seek loans from community banks rather than large institutions, at least when your borrowing needs are relatively small. “Your deal is more important to them, and there’s more negotiating room,” he says. “It’s a better deal.” And Ami Kassar, founder of Multifunding, a start-up that helps businesses find financing, pursues only deals in which the business owner can work directly with the people who approve the loan. “At a big bank, the underwriter and the loan officer working on it are often in different states and don’t even know each other,” Kassar says. “If we’re not dealing with the decision makers, we won’t go there.”

Still, many entrepreneurs are drawn to the wider array of services and more advanced technology offered by big banks. Since 2008, the 25 largest banks’ share of small-business loans has grown 5 percentage points. Regardless of the size of the bank, borrowers need to read the terms of their contracts carefully. “It baffles me,” says Todd Massas, a manager at Plaza Bank, a community bank in Irvine, California. “Clients are hypnotized by interest rates even when they’re getting pummeled by a baseball bat.”

It’s worth noting that all but one of the entrepreneurs profiled in this story found new banks. Still, the credit squeeze remains fresh in the minds of many business owners. In January 2011, JBC’s Joe Bliss moved his equipment loan and credit revolver to FirstMerit Bank, a regional bank in Akron. After sales grew fast enough that he believed he could double his manufacturing capacity, he decided to put the experience behind him and take out a new loan. Banks made offers. Even Charter One. But when JBC heard the bank’s presentation, the company’s controller, Rick Gucwa, cut the conversation short. “How do I know you’re not going to screw me again?” Gucwa asked Charter One’s rep.

That’s something all banks, as they attempt to rebuild their small-business portfolios, should keep in mind. For entrepreneurs business is, almost by definition, personal. Some will have a harder time than others with accepting the new nature of lending. In April, Moyal laid off all 120 employees at his New Jersey facility. In July, he auctioned off his old presses. Since he retrenched in his smaller Manhattan operation, sales have dwindled from $17 million at their 2007 peak to a projected $9 million in 2012. The Mitsubishi press remains in storage. Moyal sounds as much like a spurned lover as a businessman. “I want to hurt them really bad,” he says. “I am dying to know who forgot about all the years of relationships and said, ‘You know what? The guy never defaulted on a payment or anything. But too bad.'”